Background:
My initial interest in Euronext (OTCMKTS:EUXTF) (EPA:ENX) came after reading this FT article in February which mentions that the Amsterdam Stock Exchange seems to be a big winner of Brexit, but that in the long run Paris could come out on top as most of the trading in European shares will move “on shore” to the continent.
Q4 2020 hedge fund letters, conferences and more
What I found interesting is that Frankfurt doesn’t seem to be a big winner but that both, Amsterdam and Paris belong to stock listed Euronext NV Group. Personally, a lot of my own small cap investments are listed on Euronext , but so far I really thought that Euronext is more a collection of “back water” exchanges like Dublin. Lisbon or Brussels rather than a more serious competitor to LSE and Deutsche Börse.
Euronext the company
Euronext has a colorful history, among others they merged and de-merged with the NYSE. After going public in 2014, they have been rolling up smaller European stock exchanges, among them Dublin (2017) and Oslo (2019).
Their biggest move is yet to come: After the Merger of LSE and Refinitiv, Euronext agreed to buy Borsa Italiana for ~4,3 bn EUR, the transaction will be executed in the first half of 2021. After the transaction, Italy will be the biggest country by revenues for Euronext.
Multiple fundamental tailwinds
Euronext did already benefit significantly from a pandemic driven increase in trading in 2020 with organic sales increasing by +20% plus around +10% increase from acquisition (Norway, Denmark). Other short to mid-term tailwinds are:
- Brexit and the move of European trading from UK to the continent (see above)
- the continued increase in retail activity (Robinhood, Trade Republic etc.) which will bring a new generation of investors to the market
- Below zero interest rates make shares the only game in town also for many institutional players
- and the flood of IPOs/SPACs/listed ETFs that clearly are good for a stock exchange operator.
The upcoming Borsa Italiana transaction
As a condition of the merger between Refinitiv and LSE, LSE had to divest Borsa Italiana. Euronext finally got to acquire Borsa Italia at a relatively steep price of 4,3 bn EUR.
With 363 mn 2019 sales and 264 mn 2019 EBITDA, the acquisition doesn’t look cheap, however according to the presentation, only 28% of revenues are from trading, equity trading only amounts for 10% of total revenue compared to a share of 38% trading related revenue for Euronext.
Due to some debt financing (and of course excluding one-off costs) the acquisition is EPS accretive according to Euronext with a “mid single digit” percentage impact. Including synergies will increase “double digit”.
The business as such
Running a significant stock exchange is good business. In 2020, EBITDA margin has been 58,8% and net margin has been 35,6%. Returns in invested capital are north of +20%. These are levels that normally only can be reached by software companies or some kind of monopolies and stock exchanges clearly belong to the latter. Deutsche Börse for instance runs at ~63% EBITDA Margin, the LSE Group at around 55% in 2019.
Historically, they also had grown decently. Sales increased from 458 mn EUR in 2014 to the current 884 mn, a CAGR of 11,6%. Net profit increased from 118 mn EUR in 2014 to 315 mn in 2020 with an even greater CAGR of 17,8% p.a. These are very impressive numbers in my opinion and have been achieved with paying out ~50% of net profit as dividend.
A big question is how future growth will look like. Of course there is always the risk of a market crash, but overall securities market activity has grown over time. Especially currently, with lots of IPOs and a new generation of retail investors, volumes keep rising. Plus there might be new markets like Carbon credits, electricity etc. that might secure growth for a longer time.
It also seems that the pandemic has increased (again) the allure of active trading which should be good for exchanges,
I haven’t looked deep into further “roll up “opportunities within Europe, I think smaller players like Madrid or Vienna might potentially be targets or they can maybe grow in the areas of settlement and data services.
It might sound sarcastic, but Borsa Italia’s subsidiary MTS is the sole platform to settle Italian Government bonds. This will be a growth market for the foreseeable future in size.
Overall I do think that (ex Borsa Italiana) they will not grow as fast in the past, but a growth rate at around 50% of the last 6 years could be realistic in the short to mid-term.
Valuation
For a high quality business like Euronext, the stock is not that expensive. With a (reported) P/E of 19 and EV/EBITDA of 12,6, the stock is moderately priced. This is how things will look after the Borsa Italiana acquisition using the information given by Euronext (2,4 bn capital increase, 2 bn additional net debt, with some assumptions made by me).:
| Euronext post acquisition | |||
| Euronext | Borsa Italia | Combined | |
| Market cap | 5950 | 4325 | 8350 |
| Net debt YE 2020 | 600 | 2700 | |
| Sales | 884 | 464 | 1400 |
| EBITDA | 520 | 264 | 795 |
| Net income | 315 | 482 | |
| P/E | 18,9 | 17,3 | |
| EV/EBITDA | 12,6 | 16,4 | 13,9 |
| EV/Sales | 7,4 | 9,3 | 7,9 |
| EBITDA Margin | 58,8% | 56,9% | 56,8% |
| Net profit margin | 35,6% | 34,4% | |
| No Shares | 70 | mn shares | 100 |
| Share price | 85 | ||
| EPS (reported 2020/2021) | 4,5 | 4,8 |
We can see that EV/EBITDA goes up a little due to the multiple paid, P/E goes down due to the use of debt. Although the European stock market operators are difficult to compare, the “discount” for instance to Deutsche Boerse P/E of ~24 is hard to explain, especially looking at the historically better performance.
In the current environment, I do think that a P/E in a range of 20-25 would be justified (if you look at any other sector, such a company would command an even higher multiple in the current environment).
With 5,5 EUR per share of reported profits in 2022 (my estimate), this would translate in a price target of 110-138 EUR or a range of +30 to +60% in returns from the current share price.
Although it is not a factor for me, the fact that they pay out a decent and safe Dividend (proposal for FY 2020 is 2,25 EUR per share or ~2,6%) could be a benefit for some inevstors.
Stock chart:
The most interesting aspect of this comparison stock chart are the different dates when these stocks have peaked after the Covid-19 rebound: Deutsche Börse already in August 2020, Euronext in Oct, 2020 (after the announcement of the Borsa Italiana Deal) and LSE Group in February 2021.
Risks/ Why is the stock (relatively) cheap
I think one reason is clearly the relatively expensive Borsa Italiana acquisition and the pending capital raising. Euronext has a good track record in acquiring and integrating smaller players but a “Big Fish” lite Borsa Italiana is higher risk. There will also be extra charges in 2021 for this transaction in an amount of ~100 mn EUR pre tax. The fact that Borsa Italiana hasn’t been independent before is clearly a mitigating factor.
To be honest, I am also not clear how strong the impact of the “reference shareholders” Group is. Some of these shareholders are French Government owned which is not optimal and I think an Italian Goevnerment owned entitiy will participate in the upcoming capital increase.
Another observation is that they have a relatively large management board for a relatively small company with two more Italians joining after the Borsa Italia take over. Despite that they have achieved both, impressive revenue growth and increase in profitability since they went public in 2014.
And of course, a big market crash would in the mid term not be good for business.
Finally, there is also a small risk that “Blockchain” and “Coins” will be a real thing in a few years time and traditional exchanges will lose some of their dominance. The probability is small but as I learned the hard way, the probability is not zero.
Overview Pro’s/Cons
Pros:
- high quality business with high margins and barriers to entry (marketplace liquidity)
- Multiple fundamental tail winds (Brexit, trading boom, SPACS/IPOs/ETFs)
- Upside from large acquisition (Borsa Italiana) including less reliabce on trading
- reasonable valuation, strong historical growth rates
Cons:
- part of sales and profits market driven
- risk from big acquisition (Borsa Italiana) / capital increase
- potentially slower growth ahead
Summary:
Euronext is clearly not my highest conviction idea to be frank. But I do think that is a nice small “value trade” that could yield a decent return with an acceptable amount of risk.
The underlying business is highly attractive and Euronext has a very good track record since going public.
And as my own history shows, my highest conviction investments are only very rarely my best performers
Therefore I decided to allocate 2% of the portfolio into Euronext at a share price of 85 EUR/share. As mentioned above, my price target within the next 12-24 months is between 110-138 EUR/share.
As a game plan, I would prepared to add to the position if during the capital increase there would be strong pressure to the downside. If the stock would move up quickly to the middle of my target range i would also be prepared to take profits.
Article by Value And Opportunity
